A forward-looking dividend ETF strategy that selects quality names more likely to raise dividends while diminishing exposure to those likely to cut payouts has been outperforming.
The Reality Shares DIVCON Leaders Dividend ETF (BATS: LEAD) has increased 15.5% year-to-date and outpaced other so-called dividend achievers that include companies with a consistent track record of growing dividends.
Eric Ervin, CEO of Reality Shares, argued that LEAD is outperforming its larger competitors because the ETF focuses on dividend growth companies rather than companies who have historically raised dividends.
“Most dividend funds only use backward-looking data to assess whether a company will grow their dividends, whereas Reality Shares uses a forward-looking approach to predict dividend raises or cuts using their proprietary DIVCON methodology,” Ervin told ETF Trends in an email.
Many of the most popular dividend growth funds are based on data of prior payouts, tracking companies that have shown a history of yield growth. There is no guarantee that history will stay the same.
Furthermore, other dividend funds focus on dividend yield, which is not a good indicator of a company’s overall health. Reality Shares research shows that dividend growth stocks historically outperform the S&P 500, whereas high yielding stocks underperform.
Alternatively, the DIVCON ETF suite tracks companies based on the dividend growth of the broad market, and also those stocks most likely to increase their dividends while avoiding and even sometimes capitalizing on those stocks more likely to reduce dividends.
The DIVCON dividend health rating system tries to forecast and rank companies’ ability to increase or decrease dividends in the next 12 months by evaluating each firm based on expected dividend growth, free cash flow, earnings per share growth, recent dividend actions, buybacks and repurchases, Bloomberg fundamentals and Altman z-scores. Ereads Each company is scored into one of five categories, with DIVCON 5 representing the healthiest and DIVCON 1 showing the weakness.
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Ervin pointed out that there are only 50 large-cap stocks in LEAD’s portfolio, so investors are not getting potentially limited returns due to overdiversification, but still get the benefit of investing in an ETF.
LEAD remains relatively unknown among dividend investors as the ETF holds a little over $22 million in assets under management. However, potential investors should not be deterred.
“Oftentimes investors become too focused on AUM and price and forget performance,” Ervin added. “LEAD might only have $22 mil in AUM, but it’s more liquid than other dividend funds and can execute a trade easily. Also, it’s performance is significantly better.”
For more information on dividend-paying stocks, visit our dividend ETFs category.
Correction: DIVCON scoring methodology.